Variable Annuities Overview
October 28, 2009
Variable annuities are probably something you’ve never even considered investing in if you’re under 50 years young. However, I’ve had people write me whose parents are getting pitched fixed annuitites and variable annuities as they are getting closer to retirement. To give an idea of how variable annuities work, Victor wrote up the following overview. [Editor’s Note].
What is a Variable Annuity?
Like a fixed annuity, a variable annuity is an insurance product. The difference between the two is the opportunity for more growth and risk. In a variable annuity, an investor’s funds can be invested in mutual fund-like products wrapped inside the annuity. The value of the annuity fluctuates daily based on the performance of the chosen portfolio.
Many annuities now offer certain guarantees. An investor can purchase principal protection where they are guaranteed every penny they put in. Some also offer guaranteed growth. They will have an offer that states the investor will receive 5% or the market performance of the portfolio, whichever is higher. Both of these options are nice to have, but an investor must realize that they pay for this. These are “riders” that are added to the annuity contract and have fees associated with them.
Liked fixed annuities, variable annuities have the same type of surrender schedules. A portion may be taken out without being charged a fee, but be aware that if you have not reached 59 ½, you may be subject to an IRS penalty of 10%. All growth is tax deferred in a variable annuity.
In a variable annuity, the funds are passed directly to the beneficiaries without going through probate. In the case of a spousal beneficiary, if the option is chosen, the spouse can continue the contract as if it were theirs. These annuities, again like their fixed counterparts, can be funded with a lump some or through periodic payments.
In most cases, the typical investor of a variable annuity is retiree or a person with retirement on the horizon. Some annuities don’t even allow you to purchase them unless you are 45-50 years old. For some people, these newer annuities that include so many guarantees seem too good to be true.
Make sure you know how much it will cost to get all of these “guarantees” in an annuity. You will also want to know what kinds of investments are available inside the annuity and the health of the insurance company that is selling the annuity.
An annuity can be a very confusing thing. Annuity contracts are long and filled with “legalese.” Make sure you understand everything or speak to a financial professional and have them explain it to you before you put any money into it.
Here is a Smart Money article that takes a look at the downsides of variable annuities such as the average annual fees & commissions they charge, surrender fees, taxes on gains, and estate planning concerns.
- SEC – Variable Annuities Overview
- Kiplinger – Variable Annuities With Guarantees
- Boston.com – Variable Annuities Better Deal for the Seller
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